Vern Gowdie

Dear Reader,

‘It is thought that the pain of losing is psychologically about twice as powerful as the pleasure of gaining.’

Psychology Professors Amos Tversky
and Daniel Kahneman

The concept of ‘loss aversion’ was identified by Tversky and Kahneman in their work titled ‘Prospect Theory’.

The industry says in its ‘10 best days’ narrative, that ‘best days generally follow the worst days for stocks.’

Does this mean the industry wants investors to first suffer the ‘twice as powerful’ pain of loss BEFORE enjoying the ‘half as powerful’ pleasure of gain?

The industry’s willingness to sacrifice investor well-being with this ridiculous assertion is quite frankly, disgraceful.

Yes, over the very long term, share markets do go up.

However, on an individual level, that broad sweeping statement is completely irrelevant.

The question every investor needs to ask is: will the market go up during my investment timeframe?

And if they do, then you have to consider: will I first have to endure the pain of loss before enjoying the pleasure of gain and for how long?

Surely the better option would be to avoid the worst of the worst days and experience a fair share of the best days?

To me, that’s a more logical approach to long-term wealth creation.

Applying logic in the midst of a booming market — the time when you should be moving towards the exit — is not easy.

Fighting the emotions that accompany a surging bull market takes discipline…and an ability to shut out the industry marketing message of ‘there’s never a bad time to invest in markets’.

Clearly there are bad times that should be avoided like the plague.

My book How Much Bull Can Investors Bear is an insider’s expose of the investment industry’s spin, myths and trickery.

Here’s an extract from the book on the 10 Best Days myth:

‘The investment industry’s agenda is to keep your funds under management. They do not want investors moving funds in and out…it disrupts their cash flow.

‘Mebane T Faber, from Cambria Investment Management, released a paper titled “Where the Black Swans Hide & The best 10 Days Myth”. The paper concludes:

“We critique the ‘missing the 10-best-days’ argument proffered by advocates of buy and hold investing, as we demonstrate that a significant majority of the 10 best days and the 10 worst days occur in declining markets. We continue to advocate that investors attempt to avoid declining markets where most of the volatility lies and conclude that market timing and risk management is indeed possible, and beneficial to the investor.”

‘What Faber identified is that the majority of “best and worst” days tend to happen in declining markets. This makes sense when you think about it. A declining market is usually accompanied by big falls that are often followed by a “buy the dip” bounce.

‘The following table from the report is a country by country look at what the outcome would have been if an investor had missed both the best and worst days.

‘In every single country the outcome is the same — missing both would have delivered a better outcome.

‘The industry spin conveniently focuses on missing the best days. Whereas missing the worst days is far more profitable.

‘Why?

‘Because a 50% fall requires a 100% gain to get back to square one.’

That performance table is NOT what the institutional marketing departments want you to know about.

Fortunately, there’s a minority within the investment industry who do provide objective and balanced research.

Quality information enables investors to make an informed decision about the appropriate asset allocation for the prevailing market conditions.

One such source was featured in the book…

‘In my experience, people tend to “smell the sizzle and ignore the heat”.

‘By this I mean they’re seduced by the upside and largely ignore the downside.

‘Assets have an embedded downside risk.

‘Yet, few people really factor this into their calculations…until it’s too late.

‘That gaining of wisdom comes at a very high price…financially and emotionally.

‘The industry tells you there’s no bad time for good investments.

‘Really?

‘What about if you were seeking advice in, say, September 1929 or September 1987 or January 2000 or December 2007?

‘These are the periods just prior to the market’s most epic crashes.

‘Anyone who invested at any of those times would probably not agree with the industry’s propaganda.

‘It’s an insult to a person’s intelligence to suggest there’s never a bad time to invest. The premise doesn’t stand up to even the most basic of scrutiny.

‘This is why John Hussman’s [Strategic Allocation] White Paper is such a refreshing change to the nonsense peddled by the industry’s marketing machinery.

‘For those who don’t have the time or inclination to read his work, here’s my abridged version.

‘John Hussman has developed a model that assesses the risk versus reward trade-off between three asset classes...

• Stocks — S&P 500 Index
• Bonds — government bonds
• Treasury bills — cash

‘Here’s a couple of examples from the White Paper. The charts are US date stamped. 5 January 1973 is written as 1/5/1973.

‘The BLUE line is the risk-adjusted return of US shares…the range is from MINUS 2% to POSITIVE 6%.

‘The YELLOW line is the risk-adjusted return of government bonds…the range is from POSITIVE 2% to POSITIVE 6%.

‘The RED line is the risk-adjusted return of Treasury bills…the range is from POSITIVE 5% to POSITIVE 4%.

‘The preferred asset allocation is determined by which risk-adjusted asset class offers the best potential return on the matrix. This is shown by the dark blue dashed line.

‘The horizontal index shows it is [treasury] bills, followed by bonds.

‘The ratio of bills to bonds is then used to create the asset allocation pie chart in the bottom right corner.

‘According to the risk-adjusted asset allocation model, an investor in January 1973 would have been better off being out of the US share market.

‘Here’s what happened to the Dow Jones Index during that period.

‘Over the next two years, the Dow plunged 40% in value.

‘After a substantial correction, the dynamics of the risk-adjusted model changed.

‘Here’s the asset allocation model date stamped 4 October 1974.

‘Shares offered far more reward than risk. 

‘The model recommended a 100% exposure to shares

‘This is what happened to the Dow Jones after October 1974.

‘There was an initial drop — which just goes to show you can never pick the bottom. But anyone who adopted the recommended asset allocation was rewarded with a 50% return over the next two years.

‘This is what I mean about timing being crucial to your long-term financial well-being.

‘Those who adopted a “time in the market” approach had to hold on tight during the plunge and then have the nerve not to sell. This, believe me, is far easier said than done.

‘In the unlikely event they managed to do that, their reward was a zero return over a four-year period.

‘Whereas those who opted out of the market in early 1973, sidestepped the plunge. Their portfolio of bills and bonds earned around 6% per annum (for two years).

‘Then, when the market was offering far better value, they participated in a 50% recovery.

‘In simple maths, that’s a 62% return over the same four-year period.’

John Hussman’s view on current US market is (emphasis added):

‘Over the completion of the current market cycle, I expect that the entire S&P 500 total return since 2000 will be wiped out.’

This is what that looks like…a 55% fall in value.

To offset a worst day of this magnitude requires a return of 122% from the best days.

The long-term growth average of the US share market is around 6% per annum. Therefore, you’re looking at 20 years of best days to get back to square one.

How does this fit in with your investment timeframe?

The latest Hussman research include this assessment…

‘…by our estimates, the likely 10-year total return of the S&P 500 from current valuations is about -1.4% annually.’

MINUS 1.4% per annum return (on average) over the next decade…hardly an appealing investment proposition.

Avoiding catastrophic market collapses will not only save you a lot of money, but also saves you a whole lot of pain.

Believe me…black days do matter.

Regards,

Vern Gowdie,
Editor, The Rum Rebellion